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Testing Company, Inc. has the following combination of Debt and Equity: Common Stock: 15.5 million shares...

Testing Company, Inc. has the following combination of Debt and Equity:

Common Stock:
15.5 million shares outstanding
Par value of $5/share
Book value of $20/share
Current price on the market of $65.25
Current Beta per a reliable source 1.13

Debt:
Maturity value of $500,000,000
Current price on the market of 97.3
Coupon rate if 4%
Semiannual payments
10 years until maturity

Other information:
Treasury bill rates — 2.45%
Market premium on this type of stock — 7.1%
Tax rate — 21%

What is the company’s weighted average cost of capital (WACC)?

Solutions

Expert Solution

MV of equity=Price of equity*number of shares outstanding
MV of equity=65.25*15500000
=1011375000
MV of Bond=Par value*bonds outstanding*%age of par
MV of Bond=1000*500000*0.973
=486500000
MV of firm = MV of Equity + MV of Bond
=1011375000+486500000
=1497875000
Weight of equity = MV of Equity/MV of firm
Weight of equity = 1011375000/1497875000
W(E)=0.6752
Weight of debt = MV of Bond/MV of firm
Weight of debt = 486500000/1497875000
W(D)=0.3248
Cost of equity
As per CAPM
Cost of equity = risk-free rate + beta * (Market risk premium)
Cost of equity% = 2.45 + 1.13 * (7.1)
Cost of equity% = 10.47
Cost of debt
                  K = Nx2
Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2
                   k=1
                  K =10x2
973 =∑ [(4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^10x2
                   k=1
YTM = 4.3356184219
After tax cost of debt = cost of debt*(1-tax rate)
After tax cost of debt = 4.3356184219*(1-0.21)
= 3.425138553301
WACC=after tax cost of debt*W(D)+cost of equity*W(E)
WACC=3.43*0.3248+10.47*0.6752

jeff jeffy answered 9 months ago
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